One Bank Says We’ve Been Placed In A ‘Correctional Facility’

Or at least that’s what it feels like. Because here we are talking about the same “problems” we were late last week and by “problems” I mean inflation shocks and the potential for them to catalyze an upturn in rates vol. which then spills over and pisses in everyone’s Cheerios (assuming rates vol. is a thing that can piss).

Admittedly, this has been analyzed to death over the past 72 hours and it’s not entirely clear whether, in the absence of new information, there’s much left to say. But the bottom line is that as price pressures build, so too will the pressure build on central banks to acknowledge their apparent “success” in banishing the deflation boogeyman. But that acknowledgement conjures a new boogeyman: policy shocks and the withdrawal of transparency with market participants who will ultimately be forced to cope with a situation where every hawkish lean isn’t telegraphed in advance. Implicit in the notion of policy shocks is the possibility of a policy mistake and all that would come with it both for markets and for the economy.

On Monday, BofAML is out with a new note aptly entitled “Correctional Facility” in which they warn investors that “policy rates far below pre-crisis levels are likely to magnify the impact of inflation surprises on volatility.” Here’s a visual that depicts real policy rates versus their averages during the last cycle and as you can see, pretty much everyone is looser than, well, looser than Stormy Daniels:

Here’s the key point from BofAML:

Rates volatility is likely to rise in the months ahead as history points to a spike in inflation surprises. They tend to be highly correlated with the year-on-year percent change in oil prices. This is likely to be a source of volatility, especially as our monthly investor surveys show that inflation is universally considered the top tail risk.

Ultimately, the bank’s EEMEA X-asset strategist David Hunter goes on to cite his colleague Michael Hartnett who has been grabbin’ headlines by the, well, by the you know, over the past couple of weeks with his “Bull & Bear” indicator.

“Last week the ‘bull/bear’ index of our investment strategist Michael Hartnett triggered the first sell signal since 2013, and he is calling for 5% downside in S&P [and] similarly, we are calling for a correction in EM debt with the first meaningful outflows since July 2017,” Hunter writes.

On the bright side, a 5% move to the downside will barely register on the post-crisis radar assuming any drawdown does indeed remain contained and doesn’t escape from the lab and run amok in the village prompting the locals to storm the castle and demand to know how things could have possible gone so horribly wrong so quickly.

One thought on “One Bank Says We’ve Been Placed In A ‘Correctional Facility’”

great article–better photo and caption.
but where is the vol of vol–here kitty kitty says the rottweiler!
that’s funny guys and gals–you’ve just to find humor in the shit market.
happy trading all.
time to go to my day job.
sb

Writing about a subject is the best
way to educate yourself about it, and when I flick through past work I remember how much
they taught me, if no one else. Mainly they taught me that I didn’t know very much. But they
also taught me that most other people didn’t know much either. Thus, some key themes
which stand out include the illusory control of policy makers, the presumed knowledge of
those looking to them to actively do good, the ease with which we fool ourselves, and how
best to protect capital in the face of such unavoidable uncertainty. -- Dylan Grice